Despite the turbulent trading conditions of the last year, private equity (PE)-backed businesses have continued to perform strongly.
According to Ernst & Young’s fourth annual private-equity study, the largest businesses across Europe exited by private-equity investors in 2008 achieved impressive growth under PE ownership and showed growth rates consistent with the prior three years of research.
Challenges in a New World – How Do Private Equity Investors Create Value? is an analysis of nearly 300 of the largest European businesses owned and exited by PE over the last four years.
It revealed that, from acquisition to exit, there was, on average, 15% annual growth in profits, as well as employment growth of 5% and productivity growth of 9%.
In the oil&gas sector, the companies that have been performing most strongly are those that are well managed with robust and flexible business models and characteristics such as strong contracted backlogs, operations in growth geographies, differentiated technology and provision of services around asset optimisation or cost reduction.
By selectively applying its distinct ownership model and targeted business improvement initiatives, and by taking advantage of bolt-on acquisitions, PE has been able to achieve above-market returns. Indeed, the top portfolio companies have achieved a considerable advantage over their peers – the average performance of PE-owned businesses was ahead of public-company benchmarks even after adjusting for leverage.
Perhaps surprisingly, and contrary to public perception, PE investors have also remained committed to their poorer performing businesses. The report revealed that the average period of PE ownership for troubled investments was seven years, twice the hold period of other investments.
While 43% experienced a change in top management, 36% saw further equity injections as PE investors and managers worked hard to change strategies and implement new actions to improve profits and cash flow.
The challenging macro-economic environment does, however, appear to have had an impact on the volume of PE exits. Our findings show that in 2008, compared with 2007, the volume of PE exits fell by 66%, from 89 to 30 exits, and total entry enterprise value (EV) declined from circa 54billion euros (£49.7billion) to some 12billion euros (£11billion) – a fall of 77%.
In the oil&gas sector, this decline was more pronounced in the later part of 2008 as transactions benefited from a high oil-price environment earlier in the year.
The drop in exit value can also be partly attributed to the difficulty in raising debt, as well as the absence of IPOs (initial public offerings) in 2008.
IPOs have typically accounted for 10-15% of exits and are a critical exit route for the largest PE-owned businesses. This has led to a large number of high-value companies in portfolios still to exit and poses a real challenge for the industry in the next few years.
Without any significant IPO exits by PE in 2008 across Europe, and corporates accounting for only 26% of buyers, new PE investors were the main exit route, accounting for 74% of buyers in 2008 despite the tightening credit markets – up 50% compared with 2005.
This trend has continued into 2009 in the oil&gas sector, with notable examples being the tertiary buyout of Wood Mackenzie by Charterhouse Capital Partners and the recent secondary buyout of Viking Moorings by HSBC Private Equity.
Interestingly, the study found that “secondary” buyout deals have typically performed just as well as the primary deals, with growth and operational efficiency opportunities exploited just as frequently.
The reduced number of exits in 2008, seen alongside the average high returns that those exits achieved, reinforces the view that PE houses sold only strong businesses in 2008. If they were not certain of a high return, they held on to the asset. However, with the prospect of continued economic pressure, it seems likely that PE houses will be forced to reconsider this strategy.
Over the coming months, I think we can expect to see PE houses choosing to step back from some of their troubled investments and to seek exit opportunities for them, particularly in funds that have strong, if not already guaranteed, returns.
While there were no exits by bankruptcy in our study in 2008, the continuing economic decline in 2009 has already changed this position and these are likely to increase further this year.
We are already seeing signs of markets and financing improving in some areas and a pipeline of PE-backed IPOs. However, debt is unlikely to be available at the levels of recent years.
Reality is that if the PE industry does not exit existing investments or create strong cash flows to reduce debt levels, it will have trouble refinancing a significant amount of the debt used to acquire these businesses, much of which matures in 2011-12.
The large number of high-value assets within portfolios means PE houses will be looking more than ever at understanding the drivers of performance improvement that are most relevant to their portfolio companies.
These insights are likely to be the key drivers of success as PE prepares its businesses to take advantage of a reawakening IPO market. Greater availability of debt and increased activity from trade buyers will lead investors to focus on “exit readiness” for companies in their portfolios.
Barry Fraser is transactions advisory services director for Ernst & Young in Scotland
Recommended for you
